This analysis is intended to introduce important early concepts to people who are starting to invest and want to better understand how you can grow your money by investing in FMC Corporation (NYSE:FMC).
Purchasing FMC gives you an ownership stake in the company. Owing to this, it is important that the underlying business is producing a sufficient amount of income from the capital invested by stockholders. This is because the actual cash flow generated by the business dictates the potential for income (dividends) and capital appreciation (price increases), which are the two ways to achieve positive returns when buying a stock. Therefore, looking at how efficiently FMC is able to use capital to create earnings will help us understand your potential return. Investors use many different metrics but the analysis below focuses on return on capital employed (ROCE). Let’s take a look at what it can tell us.
What is Return on Capital Employed (ROCE)?
As an investor you have many alternative companies to choose from, which means there is an opportunity cost in any investment you make in the form of a foregone investment in another company. The cost of missing out on another opportunity comes in the form of the potential long term gain you could’ve received, which is dependent on the gap between the return on capital you could’ve achieved and that of the company you invested in. Hence, capital returns are very important, and should be examined before you invest in conjunction with a certain benchmark that represents the minimum return you require to be compensated for the risk of missing out on other potentially lucrative investments. To determine FMC’s capital return we will use ROCE, which tells us how much the company makes from the capital employed in their operations (for things like machinery, wages etc). I have calculated FMC’s ROCE for you below:
ROCE Calculation for FMC
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = US$888m ÷ (US$9.7b – US$2.4b) = 12%
As you can see, FMC earned $12.2 from every $100 you invested over the previous twelve months. A good ROCE hurdle you should aim for in your investments is 15%, which FMC has just fallen short of, meaning the company creates an unideal amount of earnings from capital employed.
What is causing this?
The underperforming ROCE is not ideal for FMC investors if the company is unable to turn things around. But if the underlying variables (earnings and capital employed) improve, FMC’s ROCE may increase, in which case your portfolio could benefit from holding the company. Because of this, it is important to look beyond the final value of FMC’s ROCE and understand what is happening to the individual components. Looking at the past 3 year period shows us that FMC boosted investor return on capital employed from 10%. We can see that earnings have increased from US$531m to US$888m whilst the amount of capital employed also grew but by a proportionally lesser volume, which suggests the larger ROCE is due to a growth in earnings relative to capital requirements.